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Fannie, Freddie Knew About Risks, Ignored Them

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Executives focused on profits, not prudence.

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Look, I've got certain information, certain things have come to light, and uh, has it ever occurred to you, man, that given the nature of all this new s**t, that, uh, instead of running around blaming me, that this whole thing might just be, not, you know, not just such a simple, but uh - you know?
- The Big Lebowski

Unprecedented. Unpredictable. Unparalleled. Extraordinary.

These are the adjectives offered by mortgage industry executives defending their relative innocence in the collapse of the housing industry. Conditions, they argue, deteriorated so rapidly and in such unpredictable ways they couldn't possibly batten down the hatches fast enough.

As it turns out, that's not exactly true.

The Washington Post reports that chief executive offers at both Fannie Mae (FNM) and Freddie Mac (FRE) ignored warnings about their firms' exposure to risky loans. The findings of the House Committee on Oversight and Government Reform are being discussed today on Capitol Hill.

At Freddie, an internal report explicitly warned that certain types of loans might default at a higher rate than expected if borrowers' true financial positions were to be made known. Furthermore -- and troubling insofar as these firms and their Washington backers actively pushed these risky loans on low income immigrant communities -- senior executives were told many such mortgages could be particularly harmful for non-English-speaking homeowners, since many didn't fully understand the confusing loan terms.

At Fannie, no smoking gun was produced, but the oversight committee discovered what it called an "underground" effort to actively buy subprime loans.

For their part, former Fannie CEO Daniel Mudd and deposed Freddie chief Richard Syron are directing the blame elsewhere - not surprising, given their well-documented penchant for obfuscation and finger-pointing. To Mudd and Syron, responsibility for the crash lies squarely at the feet of regulators and Congress: One was asleep at the wheel while bad loans ran rampant through industry as a whole; the other all but forced lenders to give out loans to under-qualified borrowers under the auspice of the Community Reinvestment Act, or CRA.

The CRA, introduced in the late 1970s but used by the Clinton administration to support the now-maligned American dream of home ownership, aims to give low-income borrowers equal access to cheap mortgages and other banking services. Think of it as reverse "red-lining," which is the outlawed practice of refusing to lend in certain neighborhoods that may be perceived as riskier than others.

Homeownership rates -- not to mention political backslapping -- surged as the housing market boomed, even as borrowers became increasingly exposed to predatory lending and risky loans. Wall Street and banks like Bank of America (BAC), Citigroup (C) and JPMorgan (JPM) saw loan portfolios balloon as low interest rates, securitization and an influx of foreign money fueled the red-hot market.
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